What is LTRO Financing. ECB LTRO Explained

02/29/201209/19/2014 by Editorial Team

LTRO is defined as the Long Term Refinancing Operations by the ECB or the European Central Bank. While LTRO has been around for the while, it came into the spotlight as LTRO was predominantly used in order to tackle the European debt crisis. The LTRO is primarily used as a mechanism to spread liquidity into the banking system itself. The LTRO is used in reference to Quantitative easing in order to stimulate/inject liquidity into the lending bank’s national economy.

To put it simply LTRO is nothing but the operations involving lending money by the ECB to other Eurozone banks at low interest rates. This was used by the Euro zone banks to in turn purchase high yield assets to make a profit or could also be passed on to businesses and consumers, which impacted the economy. LTRO’s are usually repaid within 3, 6, 12 and 36 month periods at ultra-low interest rates.

In order for Eurozone banks to purchase the loans, they put up the sovereign bonds as collateral. In the last LTRO auction, Spanish and Italian banks were the biggest buyers and used their country’s soverign bonds as collateral. In the wake of the Greek debt crisis, the Greek bonds are no longer used due to the junk status rating given by Standard & Poors.

LTRO loans come with a repayment period ranging from 3 months up to a year. The December 2011, (known as the LTRO and the Feb 29th LTRO, referred to as the LTRO2), the LTRO repayment period was increased to three years with an interest rate of 1%, this move was put in place in order to help ease the pressure off the banks to repay the loans. The december 2011 LTRO amounted to €489 billion being borrowed from the ECB and due to be repayed within three years.

Why do banks take LTRO Loans

In the light of the European debt crisis, the biggest strain on the banks have been their inability to repay the debts to the bondholders, which is one of the primary causes for a Eurozone bank to choose the LTRO way. The LTRO loans are issued during emergency funding, especially during times of crisis, such as the European debt crisis currently prevailing. Banks rely on the LTRO loans when the cost of borrowing from the private markets is too expensive or when existing funding sources stop lending money due to fears of too much exposure to the markets. Banks fall back on LTRO loans which is also refered to as cheap money.

LTRO Critics – What they have to say

In December, it was Italy, Spain, France, Greece and Ireland that borrowed the LTRO loan at €110 billion, €105 billion, €70 billion, €60 billion and €50 billion respectively. However financial analysts put their estimates that of the €489 billion that was borrowed, only €50 billion remained in the economy. So instead of creating liquidity in the larger markets, most of the borrowed money remained on the borrowing bank’s balance sheets.

Banks that tend to borrow loans from the ECB are closely watched by various credit rating agencies. Of course, borrowing money is always a black mark. There is also growing concern about the Eurozone banks depending too much on the ECB.

The LTRO usually drives the EUR stronger and is considered to be a favorable time for traders to trade on EUR based currency pairs.

How do banks use the LTRO

The LTRO loans however aren’t used for the intentions of easing liquidity but instead banks use the LTRO funds to invest in other high yield assets such as equities or to fund their carry trades. By borrowing money at cheap interest rates, it can be used to purchase other debt at high interest rates thus making money on the spread. For the LTRO2, unsurprisingly, it is projected that Italian and Spanish banks are at the forefront, making up close to 45% of the LTRO2 auction, while Germany seems to have reduced their borrowing from 30% to just 6%.

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